Is a Debt Consolidation Loan a Good Idea?

by Maggie McCormick

A debt consolidation loan may sound like a good idea, but it isn't always all it's cracked up to be. It can make your payments more manageable, but you may end up paying more in the long run. Consider your options carefully before you take out a loan--consolidating your debts makes sense only in certain situations.

Interest Rates

The higher the interest rate on your loan, the more you pay in the long term and the longer it will take you to pay off the debt. If you currently have high interest rates on your debt, you may be able to reduce the rates by taking out a debt consolidation loan. This can help you to pay your debt off faster.

Trading Unsecured Debt for Secured

Your credit card debt is unsecured because there is nothing physical backing it up. A mortgage or car loan is secured, with the item acting as collateral. In many cases, a debt consolidation loan uses the equity in your home to pay off the debts, then you must repay the new debt. Your home is the collateral on this new debt, so if you cannot repay the loan for some reason, the bank may repossess your home.

Debt Consolidation Companies

Debt consolidation companies act as an intermediary when paying off your debt. You pay them and they pay your creditors. The company will take a portion of your payment as a fee for acting as the intermediary. Essentially, they are charging you a fee for something that you can do on your own. Additionally, some companies are not very trustworthy and will make your payments late, even though you paid on time, negatively affecting your credit score.

Convenience

When you have several different debts, it is certainly more convenient to pay just one loan. This can help you budget your money more effectively and remember to make your payments on time.

Overall Costs

If you're considering a debt consolidation loan, look at the total cost of that loan compared with the total cost of paying off your debts as they are now. You may find that the lower monthly payment you're making through the consolidation loan actually result in higher overall payment because you're stretching the payment out over a longer period of time.